New Lead Trust Opportunities Created by Tax Relief Act?

Among all of the variables created by the Tax Relief Act of 2010, one yet to be addressed in this blog is a much improved environment for Charitable Lead Trusts.

Normally, I cringe at hearing anyone tout Lead Trusts. Not that I don’t love them – who wouldn’t in the nonprofit world since they are the planned gift that pays the charity now and has the family wait for their share after the term of the trust.

My problem with Lead Trusts has been their promotion by people completely ignorant of how they work. Also, they are rare. The IRS reports only around 6,000 of them currently in operation – most of which have been around for a while. A few hundred new ones a year, maybe, across the country? Low discount rates or not, they just don’t happen very often.

Rather than go into a full discussion of how they work, I will link here an article written two years ago (a little dated but still applicable concept-wise) that gives you all of the details and why they are so challenging: Understanding Charitable Lead Trusts (click on it to download!).

The point of raising this issue again came from Robert Sharpe. He mentioned the use of lower rate Lead Trusts. This is brilliant and I will explain why.

In the past, wealthy individuals were leery of using any of their Federal lifetime gifting exemption on Lead Trusts because the exemption wasn’t so high and if the Lead Trust failed to produce a gift to the family, you would have used the exemption for naught.

So, planners were forced to create what we call “zero’ed out” Lead Trust illustrations for Lead Trusts that would produce little or no gift tax reporting. In other words, the trust has to pay higher and/or over a long period so that the value of the “gift to family” is essentially zero. Problem with this is that it required Lead Trust payments of 10% or higher and/or 20 year or longer terms, or a combo of high payout and long term trusts.

When it came down to making a decision, there just seemed to be too much risk that the trusts could not produce enough guaranteed returns to guarantee the family any benefit. In many cases, the family was bettor off making a multi-year pledge, taking the income tax deductions (which, by the way were lost if they did a Lead Trust), and passing assets to heir with other means.

What changed? With a $5 million gifting window (to children and even grandchildren), and a chance that it will go down in two years (to as low as $1 million if there is gridlock in Congress – not so far fetched), now might be a time to structure a Lead Trust using some or all of the lifetime exemption amounts.

In other words, it is suddenly good advice to use that $5 million gifting opportunity NOW, instead of waiting for the Shangri-La of permanent estate tax repeal (i.e. not happening in our lifetime). Financial advisers should be counseling their clients on methods to use the exemption while it is high and Lead Trusts are a prime method (because they combine discounting of the gifts, time delay, and philanthropic goals).

Here is an example that should drive this point home. I just ran numbers this week on a $5 million Lead Trust, paying 3% ($150,000 a year) for 20 years. The reportable gift is around $2.8 million. Not a bad use of one’s lifetime exemption since with 3% payouts, there is a much greater likelihood of success for the family. You could even invest in conservative, long-term fixed income investments and see a nice remainder for the family. And, the donor gets credit for a $3 million gift.

The point is that this type of planning (more conservatively structured Lead Trusts) is new with the Tax Relief Act and something nonprofits need to understand and introduce to their top prospects.